Many businesses, such as wholesale and retail establishments, deal in numerous items or products that are either offered directly for sale, or are used in connection with a service offered by the business. Often large quantities of each of these items must be kept in inventory, i.e., purchased and stored/warehoused by, or for, the business owner for extended periods of time to ensure the items are available when needed. In addition, it is often cost-effective to purchase large quantities of a given inventory item in order to take advantage of volume discounting.
As a result, many businesses often have large amounts of operating capital invested in various inventory items owned by the business and stored/warehouse either by, or for, the business. Consequently, a significant portion of the value of a business having large quantities of inventory items is the market value, or market price, of the inventory owned by that business. Therefore, any accurate measure of the value of a business at a given time is based, at least in part, on the market value of the inventory. Consequently, any instance or situation where the value of the business needs to be determined accurately, such as when lines of credit, and interest on the credit, is based on the business value as collateral, requires a knowledge of the market value of inventory. In addition, any instance when the business owner desires to project future profits also requires knowledge of the market value of inventory versus the price paid for that inventory.
As an example, the tax liability/credit of a business maintaining large quantities of inventory is often also based, in part, on the market value of the inventory owned by that business and the projected profit from the sale of the inventory. In particular, standard accounting procedures use the Lower of Cost or Market Value (LCM) of an inventory item to determine projected profits associated with the sale of the inventory item, and therefore, the tax liability associated with the sale of the inventory item. Using LCM analysis, when the market value of an inventory item falls below the price the business owner paid for the inventory item, the difference between the price paid for the inventory item and the market value of the inventory item is treated as an expense against projected profits and this expense can be used to offset the business's tax liability by expensing the differential portion of the inventory cost.
For at least the reasons discussed above, it is often in the best interest of a business owner maintaining significant inventory to closely monitor the market value of his or her inventory. However, the time and energy necessary to monitor fluctuations in the market value of often numerous inventory items, and compare the market value of the inventory item with the purchase price of the inventory item, is frequently viewed by the business owner as unacceptable and not worth the effort. This is particularly true in the case of small businesses where the small-business owner and/or his or her employees are busy running the business and have little, or no, time for monitoring the market value of inventory. In addition, small-business owner's often feel, in many instances correctly feel, that the potential tax benefits of monitoring the market value of inventory items does not justify the resources, such as employee time or money, necessary to either pay a third party or hire a dedicated employee to monitor the market value of inventory items. Consequently, currently, many business owners choose to ignore the market value of inventory and therefore forgo the opportunity to expense part of their inventory cost and decrease their tax liability.